20 Ways To Improve
D&O

Download this FREE REPORT from
IRMI to learn the top 20 ways to address basic directors and officers (D&O)
coverage considerations, defense provisions, exclusions, excess coverage, and
coordination with other insurance.

The M&A Market for P&C Insurers

This article discusses the mergers and acquisitions (M&A) environment of the property and casualty (P&C) insurance industry and outlines recent market trends. This topic of discussion is an update to my previous publications in December 2010 and August 2012.

During the consideration of an acquisition or sale of a business, it is
common to assess the multiples of publicly traded companies operating
within the business's industry. Figure 1 graphically presents the
average monthly forward price-to-earnings (P/E) multiples of domestic,
publicly traded companies operating in the P&C industry.

The recent downward trend in forward P/E multiples, based on the decline
from the monthly average multiple for 2012, was likely influenced by
several prominent industry trends as well as certain political and
economic factors, as discussed below. Despite the downward trend, 2014
market multiples are in line with 2011 levels and still above levels
observed from 2008 through 2010, indicating overall financial strength
in the equity markets.

Overview of Industry Trends

The profitability of P&C insurers is, among other items, contingent on
the frequency and severity of catastrophic events. Significant
catastrophic events can reduce solvency of the affected companies and
compel such companies to sell due to financial distress. Accordingly,
financial performance and M&A activity within the P&C industry are
affected by catastrophic events. In 2012, certain weather-related
catastrophes, including Hurricane Sandy, which is estimated to have
caused damages in excess of $50 billion,2
resulted in significant losses across the industry. However, there were
few significant catastrophic weather events during 2013, which improved
the capitalization and financial health of P&C insurers and may
encourage M&A activity during 2014.3

Policy prices are also a potentially useful metric for assessing the
condition of the industry. Demand for P&C insurance is somewhat
insulated from macroeconomic conditions; the majority of P&C sales are
associated with existing customers, a characteristic that implies
reliance on renewals and facilitates price competition between
providers. Premiums tend to oscillate between periods of price decreases
and price increases (such conditions can be referred to as "soft
markets" and "hard markets," respectively). Notwithstanding the various
catastrophic weather events that occurred in the 5 years preceding 2014,
the P&C industry has been operating under soft market conditions due to
unfavorable economic conditions.4 Though
marginal rate improvements have occurred over the previous 2 years,
evidence suggests that premium growth may not continue. While a soft
market may be construed as a negative indicator of M&A activity,
stagnant prices may encourage certain well-capitalized insurers to
achieve economies of scale and revenue growth through consolidation.5

Given the current competitive, soft market, insurers capable of
exploiting targeted growth strategies such as the sale of new,
innovative products or the successful entrance into new geographic
markets are expected to achieve greater growth and efficiency. Companies
seeking to take advantage of these growth areas and segments may be
encouraged to engage in consolidation or look to acquire certain
business lines.

Economic Factors

The P&C insurance industry is significantly influenced by interest rate
fluctuations. The most recent data from the Federal Reserve reveals that
corporate equities account for only 19.7 percent of the P&C insurers'
assets, which indicates that the majority of the industry's assets are
in fixed income securities.6 The Federal
Reserve's continued open market bond buying program has maintained
interest rates at historically low levels, which has negatively impacted
P&C insurers' ability to support claims liabilities and generate
profits. Although a moving target as to precisely when, the Federal
Reserve is not expected to increase the target rate until mid-2015.
Insurers may turn to alternative investment options such as real estate,
emerging markets, and commodities to stimulate investment income.7
The success of these new investment opportunities could provide
companies within the industry additional capital going forward and
possibly stimulate acquisition activity. However, the failure of these
riskier, alternative investments may dampen financial performance and
place pressure on multiples due to a higher risk profile.

Additionally, the economic recovery within equity markets may dampen
insurers' interest in raising capital through avenues such as private
equity investment and M&A activity. Whereas, in 2010 through 2012,
distressed insurers sought out M&A opportunities to dispose of certain
business lines, the favorable outlook for the S&P 500 in 2014 may
instead drive growth in the number of initial public offerings (IPOs)
within the insurance industry.8,9
If these companies turn to the public markets to raise capital in the
form of an IPO rather than seek out opportunities for consolidation or
sale to equity sponsors, strategic and financial M&A activity could
decline as a result.

Political Factors

Uncertainty for P&C insurers continues related to legislation and federal
regulation. Regulations within the P&C insurance industry regarding
capital adequacy requirements impact the level of capitalization
necessary to support new insurance policies. The adoption of such
regulations could potentially result in lower profitability and less
capital available for deployment to new opportunities, as insurers would
need additional capital to support existing revenue and growth in policy
volume. Accordingly, many insurers may be hesitant to utilize excess
capital for opportunities such as acquisition investment before these
regulations are implemented and the related impacts are evaluated.10

Furthermore, on December 12, 2013, the Federal Insurance Office released
a report on opportunities for modernization of the regulation of the
insurance industry. Increasing availability of personal demographic data
may drive regulation to be both more specific and more binding in the
future regarding the risk rating of policyholders.11
Prior to congressional action being taken on such recommendations
provided in the report, the insurance industry is not likely to see any
direct impact; however, the report does suggest the likelihood of
industry regulations increasing going forward.

Outlook

As the soft market recedes, topline growth within the P&C insurance
industry is projected at an annualized rate of 1.8 percent over the next
5 years to 2019.12 If the financial health of
large insurers continues to improve, industry participants may look to
the M&A markets as a source of growth, especially as insurers are more
capitalized following the low number of catastrophic events in 2013.
Alternatively, uncertainty regarding the effects of regulation and
investment income outside of fixed income securities on insurers'
profitability could detract from the potential benefits of an M&A
strategy in the current market. Additionally, strength in the equity
markets may encourage companies to pursue an IPO rather than a strategic
merger or sale. Given the factors noted above, considerable uncertainty
exists regarding both the volume and pricing of M&A transactions going
forward.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week,
including links to free articles from industry experts. Discover practical
risk management tips, insight on important case law and be the first to
receive important news regarding IRMI products and events.

Featured Products

Quality Risk Management Fieldbook

This step-by-step guide is not a textbook but is the perfect resource
if you lead a small business, nonprofit, government entity, or political
subdivision and do not have risk management expertise or staff.
Everything is included to help you work alongside your insurance agent to
protect and preserve your organization. Learn more.

Glossary of Insurance and Risk Management
Terms

This best-seller from IRMI gives you quick answers to questions
involving unfamiliar insurance terminology. The definitions are written
in plain English with a focus on practical application. Learn more.